Shortages, disequilibrium, and the current adjustment process that causes inflation and slowdowns

The problem with the economy is a disconnect between demand and supply which has been playing out since the pandemic and the switch from an unconstrained financial system to a constrained system. 

Oh, that seems like an easy thing to say, but the current inflation and potential recession problem is that we are still trying to balance out the disconnect from the pandemic. Restrictions on demand with strong fiscal policy has led to excess demand in some key sectors. Supply side dislocation and logistic problems have led to shortages on the other side. Think of an economy in disequilibrium which cause dislocations in production and pricing. The labor and demand markets need time to adjust, and the process of adjustment has led to inflation and slowdowns in growth. This is not the only issues, but it plays a key part. Additionally, low rates have not served as any discipline on credit. Poor firms have not had to discipline their behavior because the cost of capital has been so low. That is now changing, which creates a different disequilibrium. The current economy must come to grips with this ongoing adjustment process.

Hat tip to Joseph Politano of Apricitas Economics in his post "Monetary Policy in a Shortage Economy" for resurrecting some interesting work from Janos Kornai on the economics of shortages. Shortages can occur in a planned economy when there is no bound from profitability. State owned or firms that are not constrained by profitability will compete for resources which create shortages. The hard bound of profitability causes firms to focus on demand while in an economic environment not bound by profitability there will be shortages as firms all grab for labor and input resources.

With low financing and zombie companies allowed to exist, there is no constraint from profitability and the process of reaching an equilibrium where poor companies no longer exist and good companies thrive does not occur. Higher rates will allow for a better allocation of resources; however, before that occurs there will be economic pain. 

Why discuss this macro theme? With all the focus on inflation, there has been less focus on the core issue of reallocation of resources as rates normalize and this will be where the greatest risks and opportunities will occur.